Recent Posts:

What I’m about to say will take a little explaining, but hear me out. China’s growth is slowing rather markedly. Yet the outlook for the luxury-goods sector, which depends on China for its growth, has never been brighter. I’ll explain my rationale in a minute, but first let me say a few words about the luxury sector in general.

At a time when most retailers are still struggling to move their merchandise, most high-end watch and jewelry retailers are selling their inventory so quickly they’re having a hard time keeping items in stock.

Last year, which saw financial markets convulse over fears that Europe was in the early stages of a meltdown, was a record year for Swiss watch exports — they climbed a full 19%. Yes, Switzerland, the same tiny, mountainous country in the heart of Europe that depends heavily on its oversized financial sector — a financial sector with strong ties to the European Union’s troubled banks.

In the midst of Europe’s worst financial crisis sinse the Second World War, business for the Continent’s makers of expensive baubles has never been better. According to the Federation of the Swiss Watch Industry, “growth in the last 20 years has never been stronger.” And this despite a punishingly strong Swiss franc, which makes exports artificially expensive.

As you might expect, much of the surge in demand is from China. As FT writes:

“The country that has emerged as crucial to almost every manufacturer is China. Sales in the Asia-Pacific region — for which generally read China — have boomed as the world’s most populous nation has increasingly gained the watch and jewelry buying bug. Part of the upturn in Europe is also attributed to Chinese tourists.

“Data for watch exports in 2011 showed China moved up one notch, to third place in sales by country, with a near 50% leap in exports, to SFr1.64bn. Add separately counted Hong Kong, where exports rose by more than 28% to SFr4.0,9bn, and the region’s influence comes into full relief.”

Swiss watches are just one example. Sales of high-end handbags, jewelry, and even luxury autos continue to be strong. Just this week, BMW reported its strongest February in its history. Again, much of this is due to China’s overwhelming influence.

Now, with all that said, how can I possibly be bullish on luxury when China’s growth is slowing? You see, dear reader, the devil is in the details.

This past week, at the annual opening ceremony of parliament, Chinese Premier Wen Jiabao cut the government’s growth target for the first time in eight years. At 7.5%, this is the first time that China’s growth rate will have dipped below 8% since 2004.

First, I’ll say the obvious: Growth of 7.5% isn’t too shabby, even if it is below China’s recent breakneck growth rates. It still makes China one of the fastest-growing economies in the world. As a point of reference, India — the other emerging-market giant — is expecting growth of only 6% this year.

But here’s where the news gets interesting: Wen announced to parliament that “the key to solving the problems of imbalanced, uncoordinated, unsustainable development [in China] is to accelerate the transformation of the pattern of economic development. This is both a long-term task and our most pressing task at present.”

In other words, it’s time for a major shift in Chinese policy. Wen has made it his stated objective to de-emphasize exports in favor of boosting domestic consumption.

I will repeat something this month that I have said numerous times in the recent past: China will eventually have a hard landing. Mark my words: It will happen. This is how all bubbles eventually end, and China’s will be no exception.

And yes, China does indeed have a bubble in capital spending — investment accounts for over half of all spending in China, according to FT. (This compares to less than a third in emerging markets as a whole.)

Eventually, China’s overcapacity will cause a deflationary depression in China that will rival the one Japan experienced in the early 1990s.

But that day is not today. Growth of 7.5% hardly constitutes a “hard landing,” and China’s domestic market still has a lot of room to grow.

The Sizemore Investment Letter remains bullish on Chinese consumers and the American and European companies that sell to them. Last month, I recommended European luxury goods behemoth LVMH Moet Hennessey Louis Vuitton (PINK:LVMUY) to my subscribers, and I’d like to reiterate that recommendation today.

LVMH is the broadest play on the boom in all things luxury — clothes, handbags, jewelry and high-end booze. It’s a one-stop shop for everything that the nouveau riche in China and other emerging markets are buying.

This article is an excerpt from the March 2012 issue of the Sizemore Investment Letter.